ABOUT MONEY: Fang Peilin (left), Chairman of Wenzhou Fangxing Guarantee Co. Ltd., discusses his company's financing business with his colleagues (HAN CHUANHAO)
When it comes to underground or black market lending, a major source of financing for small and medium-sized business owners, the Chinese Government had taken much the same approach as a legendary hero combating a mythological hydra: decapitating the many heads in an effort to slay the beast. Even now, as the government steps up efforts to tighten credit, the heads of the underground lending realm are sprouting up as fast as they are being cut off, causing China's leaders to rethink their strategy.
Remarks recently made by a central bank official have been regarded as the government's official recognition of unofficial private lending, according to Xinhua News Agency.
"Private lending is a beneficial and necessary complement to formal financing channels," the official said.
These alternative, and illegal, channels meet certain financial needs of various social institutions, especially small and medium-sized enterprises (SMEs) and agriculture-related sectors, said the central bank official. Private lending is also conducive to forming a multi-tiered credit market.
With the rapid development of small-loan companies, the government should regard them as professional lenders, and they should be covered under the government's monitoring system. In the meantime, the official urged a crackdown on crimes like illegal fund raising, loan shark practices and money laundering.
The interest rate of any private loans should not exceed four times that of bank loans, said the official, citing an existing rule set by the Supreme People's Court. He said any rate exceeding this amount is exorbitant and is not protected by law. The disputes stemming from the interest rate should be brought to the court which will determine the effectiveness of the loan contract between the two parties involved.
"Relative departments are studying, trying out and improving a tracking and monitoring system on private lending to provide more comprehensive information for economic decision making and macro-economic control," said the official.
The remarks came amid a credit crunch in the eastern city of Wenzhou, an economic hub for Chinese SMEs, which has caused a number of industrial bosses and business owners to leave the city and even the country in some extreme cases.
The central bank has raised benchmark interest rates three times this year and hiked the reserve requirement ratio for lenders six times, making it difficult for small businesses to borrow from banks.
Many small businesses in Wenzhou turned to high-interest black lending market since they couldn't get bank loans after the government tightened lending to clamp down on inflation. However, due to the bleak international and domestic market conditions, entrepreneurs later found they could not repay the loans. According to a 21st Century Business Herald report, by the end of October this year, a total of 228 entrepreneurs had run away and nine committed suicide. The number is on the rise.
Analysts believed the central bank official's remarks are meant to track those loans and standardize them so the interests of both sides can be properly protected.
China International Capital Corp. Ltd. issued a research report on China's private lending in October, noting that private lending is expected to reach 3.8 trillion yuan ($584.61 billion) in 2011, rising 38 percent year on year. This is equivalent to 7 percent of all bank loans.
The private lending business has attracted a diverse cohort of participants: guarantee companies, pawn shops, small loan businesses, investment and leasing companies, private enterprises and individuals with deep pockets.
The loans in the underground system often come with exorbitant interest rates of up to 70 percent. Private lending crises, with capital fund breakdowns of so-called guarantee companies, are increasing in frequency. A growing number of owners of SMEs have begun to abandon their operations and hometowns, taking to the road to avoid loan sharks.
Zhou Dewen, President of the Wenzhou Small and Medium-Sized Enterprise Business Development and Promotion Association, said the interests of lenders and borrowers could only be protected and come under government monitoring if their conduct is legalized.
Strapped for cash and shunned by big banks, SMEs are often forced into the arms of private lenders who provide necessary funding at a hefty interest rate.
"I borrowed 700,000 yuan ($107,692) from other businessmen, and the monthly interest rate is 5.8 percent. The sum was just to get the production line started," said Liu Hao, a small furniture company owner in Guangzhou, south China's Guangdong Province.
Liu said it has been hard to get loans from banks this year, and he got the money from his peers at a yearly interest rate as high as 60 percent. A bank loan would have come with an interest rate of 6.65 percent.